By Chetan Ahya & Deyi Tan | Singapore & Shweta Singh | IndiaFactoring in a Broadening of Credit Crunch in 2009Financial markets have deteriorated rapidly since early October. We no longer feel comfortable with our ASEAN GDP growth forecast of 3.5%Y for 2009 and are now lowering it by 1.5pp to 2.0% to reflect a higher degree of collateral damage from the credit crunch. The credit problem is turning out to be more severe, and not only in terms of the depth of the impact in the epicenters of the developed world. Liquidity problems are also reaching the shores of emerging markets, and tight credit conditions are no longer a problem faced only by the private sector. Below, we outline the extension of the credit crunch in terms of depth, geography and sectors:
• From financial markets to real economy: The transmission from credit market deterioration to the real economy is leading our US and Europe economists to further downgrade their GDP forecasts for 2009 from -0.2%Y and 0.2%Y, respectively, to -1.3%Y and -0.6%Y. As a result, we now expect the industrial world to contract 0.9%Y in 2009 from 0.1%Y previously, with ramifications for trade demand for ASEAN. The industrial world accounts for 52% of the global economy, and the US, EU and Japan still constitute around 28% of ASEAN's export market demand.
• From developed world to emerging markets: The credit crunch is not just being felt in developed economies. The impact is also percolating in the emerging markets as the supply of risk capital reverses. Risk-aversion will deprive emerging markets of capital, and the real economy implications would be all the more severe if growth had been credit-dependent over the past few years. Export demand from emerging markets had been one of the last dominos to fall in the de-coupling story. Global demand destruction and the spillover into commodity prices were already negatively affecting the terms of trade for commodity-producing EMs. The further shutting of the liquidity tap will deliver a double-whammy, in our view.
Anecdotally, EM commodity producers are seeing an increase in defaults by end-market wholesale traders. Traders are now finding it hard to break even, as spot prices have fallen significantly from the contracted prices. This will likely create a vicious cycle, leading banks to pull back further on letters of credit (LCs) at a time when they are already in short supply. This not only has the indirect impact of slowing export demand from EM. ASEAN economies such as Indonesia are also directly affected as their CPO contracts are defaulted on.
• From private sector to sovereigns: The credit crunch is no longer localized in the private sector; it is now also infecting sovereign debt. In this regard, the nationalization of the pension fund in Argentina aggravated sentiment, particularly for emerging market sovereigns. ASEAN sovereign CDS spreads have since retraced their steps, but they remain 150-450bp above the levels seen in January 2008. Specifically, ASEAN economies with a relatively higher share of external public debt and perceived currency vulnerability (Indonesia) have seen a disproportionately bigger widening in their sovereign CDS spreads. On the other hand, Malaysia and Thailand have seen a relatively smaller increase in their CDS spreads, from 43bp and 57bp, respectively, in early 2008 to 210bp in November 2008. Unless the government has a pristine balance sheet, the spillover of the credit crunch from the private to the public domain – and consequently higher costs of fiscal financing – is likely to undermine how aggressively ASEAN governments can engage in fiscal pump-priming.
Assessing ASEAN in a Three-Factor FrameworkAs developed economies likely contract in 2009, ASEAN economies will face their most difficult test since 2001. To set the context, while the 1997-98 financial crisis had its epicenter in the East, this credit crunch was not made in Asia. The debt supercycle in the US saw American financial institutions, GSEs, corporates and households leveraging up. However, ASEAN economies (government, corporates and households) have deleveraged coming out of the 1998 crisis. Bank credit (as a percentage of GDP) fell from 60-166% of GDP at the peak to 25-100% in 2007. Government debt similarly fell from peak levels of 61-93% of GDP to 35-42% in 2007. Macro imbalances such as the current account deficits that most ASEAN economies were running prior to the 1998 crisis had also given way to either a surplus or a milder deficit.
To the extent that macro problems are not domestic in ASEAN, better fundamentals will enable ASEAN to quickly regain its footing once the global macro recovery is in sight. Yet, ASEAN remains vulnerable to the spillover impact from the credit market fallout. In our view, the relative ranking of ASEAN macro vulnerability hinges on what we see as a two-fold transmission mechanism and the propensity/ability for monetary and fiscal policy response, which we outline below:
• Who is most addicted to risk-capital liquidity? Overall balance sheets are less overstretched compared to 1997-98. However, economies that have, at the margin, been most dependent on leverage as a fuel of economic growth would be most affected, as liquidity becomes scarcer and more costly in this deleveraging cycle. The source of credit funding is also critical. In an environment of risk-aversion, economies that had been running a credit cycle alongside current account deficits are likely to see the most disruptive tightening of liquidity conditions. By these measures, we believe that Indonesia is most vulnerable, followed by Singapore, Thailand and then Malaysia, as credit growth in the latter two remained relatively subdued.
Indeed, we believe that the disruptive tightening in liquidity conditions for Indonesia could be further exacerbated. The rupiah remains vulnerable to depreciation pressures and liberal capital account convertibility. If the central bank chooses to intervene to preserve FX stability, it will withdraw liquidity (buying rupiah and selling dollars) from the system at a time when liquidity conditions are tight. In addition, the fall in commodity prices could further depress the commodity trade balance at a time when the non-commodity trade balance has already fallen into negative territory. On the other hand, Singapore also had a strong credit cycle with loan growth at 24.8%Y in September 2008. Its liquidity conditions are less dismal, given the huge current account surplus and the central bank's excess liquidity pool. Nonetheless, Singapore banks have not been immune to widening financial CDS spreads. Lending spreads have risen, and bank lending standards have tightened.
• Who is most exposed to global trade and asset markets? Economies with a smaller domestic demand base and higher trade and asset market linkages will be more susceptible to a bigger growth deceleration in this coming global slowdown. In this regard, we believe that Singapore remains most vulnerable, followed by Malaysia, Thailand and then Indonesia.
Indeed, Singapore's dependence on external demand is further undermined by the relative underperformance of its exporters. Its electronics export industry lags in terms of technology and does not have a fully integrated tech food chain or strong local brand names, as is the case with Taiwan or Korea. Moreover, its biomedical exports are notoriously volatile, as production remains dominated by a few key players. Malaysia faces a similar problem with its non-commodity exports. Its exporters of integrated circuits and telecommunications equipment saw their global market shares decline from 8% and 4.5%, respectively, in the early 2000s to 6.5% and 2.6% in 2006.
• Who has the ability and wherewithal to undertake policy responses? The ability to cushion the downcycle would depend on the authorities' propensity for and the extent of policy responses. However, widening spreads, a change in the pricing of risk and tighter lending standards have rendered the monetary policy easing less effective than usual. Indeed, despite the rate pause, we believe that monetary policy rate changes have already ceased being an effective signaling tool in Indonesia, as automatic tightening by the market will likely continue. Nonetheless, economies where the central banks are sitting on reasonable liquidity (i.e., Malaysia) and that have not seen a strong credit cycle (i.e., Malaysia and Thailand) – hence have a lesser possibility of bad lending – will likely experience a higher degree of success in terms of monetary easing.
As discussed earlier, fiscal expansion is likely to be constrained by a higher cost of fiscal financing, particularly for Indonesia. Despite the 2009 elections, the Indonesian government expects the fiscal deficit to narrow to 1% of GDP from 1.3% in 2008. Malaysia and Thailand's fiscal pump-priming would similarly be constrained by rising financing costs. The Singapore government has the most gunpowder, given its history of fiscal surpluses, and the government is also looking to revise regulations to unlock more of its SWFs' expected stream of capital gains for government expenditure. However, in spite of the anti-cyclical stance, we note that Singapore's fiscal expansion tends to be less aggressive than its ASEAN neighbors. Recall that the fiscal deficit stood at around -0.9% of GDP in F2001 and -1% of GDP in F2003. Our ranking in terms of policy responses is Singapore (more effective), Malaysia, Thailand and then Indonesia (less effective).
Based on the above three criteria, the pecking order for ASEAN macro vulnerability in a downcycle would be Indonesia (most pain), followed by Singapore, Malaysia and then Thailand (lesser pain).
A Tepid Growth Recovery in 2010We are simultaneously rolling out our forecasts for 2010. As highlighted by our global economists, Joachim Fels and Richard Berner (see Beyond a Deeper Recession: Tepid Recovery, November 10, 2008), our macro team expects the 2010 recovery to be anemic rather than dynamic, mainly because still-lower asset values and slower growth constrain consumer spending while negative operating leverage makes it less compelling for capital investment. Moreover, credit costs are also likely to be structurally higher from regulatory reforms.
As a result, we expect ASEAN 2010 growth to come in at 4.4%, significantly lower than the five-year average of 5.8% seen between 2003 and 2007. We continue to see the risks to our forecasts as skewed to the downside, with 1% global growth as a real possibility.
